The world’s second biggest mining company and one of the biggest iron ore producers Rio Tinto (RIO) has recently posted record production result for its third quarter due to an increase in the production and shipments of iron ore, particularly in Western Australia. The company has reaffirmed its annual iron-ore production guidance at 265 million tons.

Rio Tinto has increased its iron ore production by 2% year-over-year to 68.3 million tons while global iron-ore shipments rose 4% year over year to 68 million tons. This is due to the record production of 64.3 million tons from its Australian Pilbara operations. The business is also one of the lowest cost iron ore producers, so the increase in production should help it to deliver better results for the third quarter. The details of Rio Tinto’s third quarter production are shown in the table below.

Previously, for the six months ending in June 2013, Rio Tinto’s net profit dropped by 71% to $1.72 billion from same period of 2012 while revenue was $27 billion. The company gets most of its revenues from iron ore, followed by aluminum and copper.

The company has been suffering due to the lower commodity prices, higher tax rate and the fall in demand at its biggest market, China. However, the company’s aggressive cost-saving measures were able to offset some of the decline in profits.

Cost Reductions

Rio Tinto has planned to reduce its operating cost by $5 billion by December 2014. In first half of 2013, the company cut its costs by around $1.5 billion. Rio’s target for the current year is to cut its costs by $2 billion. It has reduced $438 million in exploration and evaluation spending, which is two-thirds of the $750 million reduction target. Its capital expenditure during the first six months dropped by $668 million while the company will spend a total of $14 billion this year in capital expenditures, a reduction of 20% from last year to $14 billion.

Besides reducing its costs, Rio Tinto has been selling its non-core assets and increasing its focus on its core higher value operations. In the first six months of the current year, Rio reported total divestitures of $1.9 billion.

Challenging Business Environment

The slow growth in China and the lower iron ore prices are also having an adverse impact on Rio Tinto’s rival and the world’s largest miner BHP Billiton (BHP). Due to the challenging business environment, BHP has closed its mines, sold its assets (like the sale of its 15% stake in Jimblebar iron ore mine of West Australia) and cut around $2.7 billion of controllable costs. Others, such as Cliffs Natural Resources (CLF), are also struggling due to the weakness in iron ore prices. The company also has higher labor and mining costs than its rival Rio Tinto and BHP Billiton.

However, the good news for Rio Tinto’s investors is that, according to Credit Suisse, in this difficult environment, the miner is in a significantly better position than most of its rivals. The company’s competitive advantage comes from its lower costs. In fact, Credit Suisse has pointed out that Rio Tinto is “the world’s lowest cost iron ore producer of scale.”

Big Decisions on Chinese Growth

Rio Tinto believes that the demand of steel in China will rise at an annual growth rate of 3% in the next decade. This increase will come due to an uptake in construction activity related to skyscrapers and the development of industries, such as automobile.

Overall, China will experience a significant uptake in steel demand from the 1990 to 2010 period to the 2010 to 2030 period. This increase will create considerable growth opportunities for Rio Tinto as China has been the fastest growing market and is the biggest contributor to the company’s overall revenues.

In order to meet the future demand from China, as well as other markets, Rio Tinto has geared up its production in the Pilbara region. The business has planned to achieve the iron ore production volume of 290 million tons annually till the mid of 2014, an increase of 25% from 2012. The mining giant is also considering increasing its annual iron ore production to 360 million tons by investing an additional $5 billion by 2016. This would take the Rio Tinto ahead of Vale (VALE), the world’s leading iron ore producer. Vale is expecting output of 326 million tons for the current year while industry experts believe that it can produce around 350 million tons next year.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review.Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

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